May the Stay be with you…

From next week the much hyped stay on ipso facto rights in certain contracts will be law. The relevant Legislation, Regulations and Declarations commence this Sunday, 1 July 2018.

This reform is part of a broader suite of amendments (including the introduction of the safe harbour) to the Australian insolvency regime that the Federal Government hopes will promote entrepreneurship, drive growth and reduce some of the stigma associated with insolvency.

The stay operates to prevent the termination or modification of a contract should the counter-party become subject to insolvency (either voluntary administration, receivership or a scheme of arrangement to avoid winding-up) and otherwise be performing its relevant contractual obligations. The previous operation of ipso facto clauses had the ability to reduce the scope for successful restructures or the sale of businesses as a going concern and also allow a counterparty to attempt to ‘green mail’ as part of negotiations.  

Our earlier article identified the key points based on the drafts of the relevant legislation. Below we set out the final position, much of which is unchanged.

Key Points

• New contracts only - The stay only applies to new contracts entered into after 1 July 2018.
• Only insolvency - The stay does not apply to termination rights arising from breaches not associated with insolvency (for example non-payment or failure to provide relevant services).
• Exclusions - There is an extensive list of exclusions from the operation of the stay (including in excess of 30 different types of contracts, agreements, arrangements and rights which are specifically excluded in the Regulations / Declarations).
• Safe Harbour - The stay does not apply to a company entering into or taking advantage of the safe harbour regime.
• Amendments or novations - There is a 5 year transitional period for variations or novations of pre-1 July 2018 contracts (i.e. a variation or novation of a contract entered into before 1 July 2023 will be carved out of the operation of the stay). This contrasts with the open-ended position in the draft regulations.

Observations on likely impact

• Don’t believe the hype - Despite the hype there is unlikely to be an immediate material impact given the stay only applies to new contracts.
• Don’t panic – Parties considering entering into new contracts should not panic about the operation of the stay, and should focus on ensuring there are robust and appropriate non-insolvency termination rights.
• Opportunity to still terminate - Given the exclusions and potential non-insolvency defaults that occur in a distressed scenario it is likely that many contractual counterparties will still be in a position to terminate their contracts should they wish.
• Personal liability for goods - Suppliers of goods will not be adversely impacted in an administration or receivership scenario given the ability to rely on the personal liability of the appointees.
• Additional complexities - Restructures or insolvency sales undertaken in the next 12 – 24 months will likely involve significant complexities as the stay may apply to some but not all contracts.

Contracts not subject to stay

Some of the arrangements and contracts contained in R5.3A.50 of the Corporations Regulation 2001 that will not be subject to the ipso facto stay include:

• Contracts, agreements or arrangements for the underwriting of an issue, or sale, of securities, financial products, bonds, promissory notes, or syndicated loans;
• Arrangements for the sale of all or part of a business, including by way of the sale of securities or financial products;
• Contracts, agreements or arrangements that involve a special purpose vehicle, and that provide for securitisation or a public‑private partnership;
• Building work, construction work or related goods  / services arrangements with total payments of at least $1 billion until 1 July 2023;
• Arrangements relating to laws and international obligations;
• Government licences or permits;
• Arrangements relating to securities and financial products;
• Contract, agreement or arrangement under which securities are offered, or may be offered, under a rights issue;
• Complex arrangements between sophisticated parties;
• Arrangements relating to debt and the ranking of creditors;
• Arrangements relating to financial markets and clearing and settlement facilities; and
• Netting arrangements.

Rights not subject to stay

The kinds of rights that will not be subject to the ipso facto stay include:

• Uplift clauses and indemnification;
• Termination rights in a standstill or forbearance arrangement;
• Right to change the priority in which amounts are to be paid;
• Rights of set-off and acceleration of such rights;
• Rights of assignment and novation;
• Certain self-executing provisions; and
• Step-in rights.
• The right to appoint a controller will also be excluded from the stay where certain circumstances are satisfied. This proposed carve-out recognises that contractual arrangements between parties as to the priority of secured creditors in insolvency events and the exercise of rights should not be disturbed, and prevents an outcome which promotes a race between creditors to appoint a controller.

Conclusion

The stated purpose of the stay is to preserve value through restructures and promote going concern sales undertaken through an insolvency process (especially in contract heavy businesses). The legislature at the same time has taken a relatively broad stroke approach to the exclusions (many of which are commercially sensible and necessary).

Whether the right balance has been struck will be borne out during active restructures undertaken in the next 12 – 24 months. Each situation, or more accurately each contract, arrangement or agreement, will need to be examined closely against the legislative package as a whole when considering whether a restructure or sale / purchase is impacted. 

We recommend discussing with JWS’s Finance and Restructuring team the drafting and structuring of any new contracts or potential enforcement actions relating to new contracts.